Portfolios: Short Sales


Kerry Back

BUSI 721, Fall 2022
JGSB, Rice University

Short Sales

It is possible to sell before you buy.

You need to borrow the asset the want to sell and return it later.

This is called selling short or going short.

Long = asset (own something)
short = liability (owe something)

Always hope to buy low and sell high. But can do it in the opposite order: sell high and then buy low.

Risk is it will \(\uparrow\) and you sell high and buy higher!

Shorting to Hedge

Sometimes short to make a bet on something falling.
Sometimes short as part of a hedge.

Example: optimistic that Chevron will do well among oil companies, but not sure what price of oil will do.

Strategy: buy Chevron and short Exxon-Mobil or short oil index.

You make the difference in returns.

Example

Invest $10,000. Buy $10,000 of CVX, short $10,000 of XOM.

  • Assets: 10,000 CVX, 10,000 cash
  • Liabilities: 10,000 XOM
  • Equity: 10,000

CVX \(\uparrow\) 20%, XOM \(\uparrow\) 10%

  • Assets: 12,000 CVX, 10,000 cash
  • Liabilities: 11,000 XOM
  • Equity: 11,000

Some Issues

Have to pay stock borrowing fee (usually small)

Will not get full interest on short-sale proceeds.

  • In example, $10,000 \(\rightarrow\) buy CVX.
  • Shorting XOM \(\rightarrow\) $10,000 cash.
  • Cash is held as collateral against short sale.

Margin requirements:

\[\sum_{i=1}^n \lvert{w_{i}}\lvert \leq 2\]

summing over risky assets. So, must invest $10,000 to put on $10,000 long position and $10,000 short position.